ESG Investing in China

Individually, two key areas of focus which many investors have started to consider in recent years include the Asian powerhouse China and the growth of integrating environmental, social and governance (ESG) into investment decision making. But can the two be considered together?

China is often looked at separately when referencing Asia and emerging markets due to its economical size and acceleration, as well as its innovation and technology. The country has seen its GDP growth outpace the likes of India and Russia since 2000, having maintained an annual change of 6-8% each year. Even after the impact Covid-19 had on the country in 2020 following national lockdowns, factory closures and flittering exports, China still recorded positive GDP growth of 2.3% for the year. Making it the only major economy to achieve a positive change during 2020.

China has seen a growing interest from foreign investors as the country’s market becomes increasingly more accessible for those outside of the border. The Stock Connect between China’s and Hong Kong’s stock exchanges, as well as the inclusion of A Shares (Chinese onshore stocks) in flagship global indices has already started to play a pivotal role in the surge of foreign assets into the Chinese market.

These changes have come in tandem along with the perception that China is no longer just a location for cheap manufacturing. Instead, China is shifting towards a more service-based economy driven by an expanding middle class, growing consumer spending, rapid urbanisation and continued developments in infrastructure. And like the rest of the world, it is now taking a more sustainable focus which is being heavily supported by the government and enabled by technological innovation.

However, China has been implementing several changes and initiatives to help it reach its goals. Changing the mix of energy sources used in China will be critical in reaching President Xi’s targets that will ultimately play a crucial role in the Paris-Agreement’s objective of maintaining global warming to below 2°C. This is why we see two key areas, renewable energy and electrical vehicles, creating green investment opportunities within China that can also compete on a global scale.

In 2019, China spent $80 billion on clean energy research and development, significantly ahead of the US which invested $50 billion. This has resulted in China reaching grid parity, meaning the price of energy production using solar panels equals that sourced by coal-produced energy. Therefore, the argument for using coal as a low-cost energy source is much less substantiated. Due to heavy investment in renewables over the years, China’s dominance in technology and progression in solar energy now sees the country being home to the world’s leading distributors in solar panels such as Trina Solar and China Sunergy.

Other sustainable alternatives China is in the process of transitioning to is within transport. China is the world’s largest electric vehicle (EV) market, accounting for half of the world’s electric cars. The government is aiming for new energy vehicle (NEV) sales to reach around a quarter of all car sales by 2025. The country is not short of supply as we have seen a number of Chinese EV start up’s gain significant traction over the last 12 months.

One of the biggest issues that the EV market currently faces in terms of demand is the price of electric cars being more expensive compared to petrol-fuelled cars. The most expensive element for EVs is the battery however, this is expected to reach cost parity with internal combustion engines by 2023. Therefore, the price of EVs should start to become much more competitive relative to the rest of the market. Additionally, to further encourage demand, the State has extended subsidies for those purchasing electric vehicles for a further 2 years. We are at a turning point when it comes to EVs and there are clear catalysts providing a long runway of growth for this part of the market for years to come.

However, while China is taking action on becoming a more sustainable economy, underlying issues still remain which is limiting the country’s progression. For example, despite its efforts in reducing its own coal usage domestically, China continues to play a key role in financing offshore coal factories throughout Africa.

Corporate governance is another challenge within the Chinese market, one notable example is the Chinese coffeeshop chain Luckin Coffee which listed on the Nasdaq in 2019. Last year it came to light that employees had fabricated its sales figures in an attempt to rival competitors which resulted in the delisting of the company and a $180 million fine.

The social aspect of ESG in China is an important topic given the number of human rights violations within China, notably the widely documented treatment of Uighur Muslims in the north-western region. While the government has been heavily criticized for the treatment of the Uighur population, (and it should be noted that there are a number of governments across the world that do not have exemplary human rights records) much of this is out of the control of corporations that are located within the country. In fact, companies are becoming increasingly more aware of the social aspect of their businesses and engaging with investors on how to improve. This is a significant improvement, particularly for Asia where traditionally companies have been less open to this than in other geographies.

Progress is being made as the Chinese regulator has recently drafted rules on corporate governance within the insurance and banking sectors. Meanwhile, China’s regulatory commission is engaging with companies to improve the disclosure of ESG metrics to align themselves more with standards in Hong Kong. Better disclosure by companies will help investors determine which companies are addressing ESG issues and opportunities, and for those investors that are pursuing specific responsible investment related mandates, these metrics will enable investors to avoid greenwashing.

There has been a significant correlation between the amount and quality of ESG data with the demand for sustainable investing. Given the developments within this space over the past couple of years, assets within sustainable and responsible funds have ballooned compared to their non-labelled counterparts. Between 2018 and 2019, ESG-themed China ETF inflows increased by 464%, highlighting the demand for this type of exposure.

From where China was at the turn of the century, the country has come leaps and bounds in its bid to reduce its pollution levels in tandem with developing its economic footprint. If the powerhouse does achieve its sustainable goals by 2060, it will likely be the largest sustainable solution provider in the world, particularly driven by its EVs and solar panel markets. Currently, China, as a whole, is far from being the pinnacle of sustainability but the companies within it are taking action to improve this and so cannot be held accountable for the wider social issues being caused by the government. It is certainly a step in the right direction and the momentum behind it could see the sustainable market being dominated by China in the not so distant future.